It's almost funny how investors keep making the same mistakes. Maybe it is because everyone thinks they can predict the market, maybe temptation gets the best of us, or maybe it is because we are just plain impatient. Whatever the case, here are some of top mistakes that will bite into your portfolio.
Mistake 1: Not Diversifying
Diversification has been called the only free lunch. It is one of the few things you can control to substantially reduce risk in your portfolio. While it is impossible to reduce risk to zero percent, diversification may be your answer to protecting your wealth for years to come. Here are the three keys to diversifying:
- Spread your investments between many asset classes. For example: 75 percent stocks, 15 percent cash, and 10 percent bonds.
- Keep your stock holdings in different sectors, e.g., a large cap pharmaceutical, a small cap software maker and a foreign brewer. Or just go out and purchase a couple ETFs.
- Purchase stocks with varied outlook. Speculation is not bad, but limit your high flyer's to one. And get a stock with stability, like the time tested blue chips.
Mistake 2: Chasing
Chasing the next hot stock after it jumped on rumors is a great way to increase your losses. So many investors add a stock to their watch list, witness a big jump, and pile in before gains evaporate to losses. Never buy stocks based solely on rumors, instead, do your homework, formulate a good price you are willing to pay, and use limit orders.
Mistake 3: Low Price, Cheap Stock
A low price does not make a cheap stock. Stock prices are based on the worth of assets in the company and the future value of those assets. Valuation is the key to stock prices. Berkshire Hathaway, Warren Buffets investment vehicle, has a share price of around $90,000 per share. Berkshire is way 'cheaper' than the thousands of penny stocks on a path to zero cents. To get big and small numbers into a better frame of mind use the power of ten. For instance Google (GOOG): take the price at around $400, divide everything by ten. Now look at the stock as a $40 stock.
Mistake 4: Locking in Profits
When to sell a winner is one of the toughest questions an investor must ask themselves. But being a greedy pig is a sure fire way to lose out big. Some ways to judge if your stock is ready to sell:
- The fundamentals have changed in some way.
- The valuation way above the historical average for no good reason.
- The company hit your sell target.
Investment commentator Jim Cramer (thestreet.com) recommends taking profits if your stock has run 25 percent in less than three weeks. But remember, rules are meant to be broken, maybe your company has fundamentally changed for the better.